With a new President taking office in January, many people are wondering about potential changes to the lifetime exemption amount for gift and estate taxes.

In 2018, the Tax Cuts and Jobs Act (TCJA) doubled the lifetime gift, estate, and generation-skipping tax exemption from $5.6 million to $11.18 million (adjusted for inflation). In 2020, individuals can leave up to $11.58 million to their heirs, free of estate or gift taxes [i]. The increased amount is set to sunset at the end of 2025 and would then revert back to the 2017 amount of $5 million, as adjusted for inflation, per person [ii]. There is also speculation that with a Democratic administration, it could be reduced earlier than planned.

The IRS provided guidance that there will be no clawback on lifetime gifts, meaning that any gifts made under the current exemption will not be subject to future estate tax, even if the exemption amount is reduced [iii]. This provides an opportunity for someone concerned about having a taxable estate to take advantage of the higher limits to gift money out of their estate.

For those that decide to take advantage of the higher exemption amount, the amount gifted must be substantial to make the best use of this opportunity. Because prior use of the exemption amount reduces the exemption amount available for future gifts [iv], gifting less than $6-7 million (estimated exemption amount in 2026) does not maximize the current opportunity. This would  reduce the future exemption amount to approximately $0 (with additional amounts being added each year with inflation). The impact comes when you gift large sums up to $11.58 million.

As an example, let’s assume the amount of the exemption after it sunsets at the end of 2025 becomes $6.5 million:

  • Gifting $5 million now would use up $5 million of the exemption in 2026, with a remaining $1.5 million exemption available. That brings the total possible gifts without tax to $6.5 million.
  • Gifting $10 million now would leave no remaining exemption amount in 2026, but would have gifted $10 million total without gift tax.

While gifting assets out of your estate means you are relinquishing ownership, control, and use of the assets, there may be strategies to offset this loss of ownership. One popular strategy for married couples is to set up two Spousal Lifetime Access Trusts (SLATs). A SLAT is an irrevocable trust set up for the benefit of your spouse and your descendants. Spouse A creates a trust for spouse B, and spouse B sets up a trust for spouse A. (Or just one spouse can set up a SLAT). This makes it possible for the spouses to still access assets of the trust of which they are beneficiary but keeps the assets out of their estate. One important consideration is that at the beneficiary spouse’s death, the assets in that trust would not be available for the surviving spouse [v]. So, it is important to make sure there are still enough assets out of the trust to cover expenses.

When funding these accounts, it is best to avoid low cost-basis assets, if possible. These assets would not get a step-up in basis at the person’s death, as they would if someone held them in their own name [vi].

There is no “one size fits all” estate plan, so you should review potential strategies with your estate planning attorney and financial advisor to find a plan that works best for your family.

If you have any questions or wish to discuss further, please reach out to your Team Hewins advisor.

 

[i] “How Do The Estate, Gift, And Generation-Skipping Transfer Taxes Work?”. Tax Policy Center, 2020,  https://www.taxpolicycenter.org/briefing-book/how-do-estate-gift-and-generation-skipping-transfer-taxes-work#:~:text=The%20tax%20provides%20a%20lifetime,million%20per%20donor%20in%202020 Accessed 3 Dec 2020

[ii] “Treasury, IRS: Making Large Gifts Now Won’t Harm Estates After 2025 | Internal Revenue Service”. Irs.Gov, 2020, https://www.irs.gov/newsroom/treasury-irs-making-large-gifts-now-wont-harm-estates-after-2025 Accessed 3 Dec 2020.

[iii] “Treasury, IRS: Making Large Gifts Now Won’t Harm Estates After 2025 | Internal Revenue Service”. Irs.Gov, 2020, https://www.irs.gov/newsroom/treasury-irs-making-large-gifts-now-wont-harm-estates-after-2025 Accessed 3 Dec 2020.

[iv] “Treasury, IRS: Making Large Gifts Now Won’t Harm Estates After 2025 | Internal Revenue Service”. Irs.Gov, 2020, https://www.irs.gov/newsroom/treasury-irs-making-large-gifts-now-wont-harm-estates-after-2025 Accessed 3 Dec 2020.

[v] “What Is A Spousal Limited Access Trust Or SLAT? | Klenk Law”. Klenk Law, 2020, https://www.klenklaw.com/practices/irrevocable-trusts/slat/  Accessed 3 Dec 2020.

[vi] “Just What Is A “SLAT,” Anyway? | Much Shelist, P.C.”. Muchlaw.Com, 2020, https://www.muchlaw.com/insights/article/just-what-slat-anyway  Accessed 3 Dec 2020.

Team Hewins, LLC (“Team Hewins”) is an SEC-registered investment adviser; however, such registration does not imply a certain level of skill or training and no inference to the contrary should be made. The information contained within this letter is for informational purposes only and should not be considered investment advice or a recommendation to buy or sell any types of securities. Past performance is not a guarantee of future returns. It should not be assumed that diversification protects a portfolio from loss or that the diversification in a portfolio will produce profitable results. The opinions stated herein are as of the date of this letter and are subject to change. The information contained within this letter is compiled from sources Team Hewins believes to be reliable, but we cannot guarantee accuracy. We provide this information with the understanding that we are not engaged in rendering legal, accounting, or tax services. We recommend that all investors seek out the services of competent professionals in any of the aforementioned areas.

 

 

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